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Cliffs Natural Resources Inc (NYSE:CLF)

Q1 2014 Earnings Conference Call

April 25, 2014 10.00 PM EDT

Executives

Jessica Moran – Director-Investor Relations

Gary B. Halverson – President, Chief Executive Officer

Terrance M. Paradise – Chief Financial Officer & Senior Vice President

P. Kelly Tompkins – President-Global Commercial & EVP-External Affairs

Analysts

Mitesh B. Thakkar – FBR Capital Markets & Co.

Michael F. Gambardella – JPMorgan Securities LLC

Tony B. Rizzuto – Cowen & Co.

Timna Beth Tanners – Bank of America Merrill Lynch

Jorge M. Beristain – Deutsche Bank Securities, Inc.

Evan L. Kurtz – Morgan Stanley & Co. LLC

Nathan D. Littlewood – Credit Suisse Securities (NYSE:USA) LLC

Operator

Good morning, ladies and gentlemen. My name is Jessica, and I’m your conference operator today. I would like to welcome everyone to the Cliffs Natural Resources Q1 2014 Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session, instructions will be provided at that time.

I would now like to introduce you to your host for today’s call Jessica Moran, Director, Investor Relations. Ms. Moran, you may proceed.

Jessica Moran

Thanks, Jessica. I would like to welcome everyone to this morning’s call. Before I turn the call over, let me remind you that certain comments made on today’s call will include projected statements that are intended to be made as forward-looking within the Safe Harbor protections of the Private Securities Litigation Reform Act of 1995.

Although the Company believes that its forward-looking statements are based on reasonable assumptions, such statements are subject to risks and uncertainties that could cause actual results to differ materially. Important factors that could cause results to differ materially are set forth in reports on Forms 10-K and 10-Q and news releases filed with the SEC, which are available on our website.

Today’s conference call is also available and being broadcast at cliffsnaturalresources.com. At the conclusion of the call, it will be archived on the website and available for replay. We will also discuss our results excluding certain special items, which is a non-GAAP financial measure. A reconciliation for Regulation G purposes can be found in our earnings presentation, which is posted on our website at cliffsnaturalresources.com.

Joining me today are President and Chief Executive Officer Gary Halverson; Executive Vice President and Chief Financial Officer; Terry Paradie; and Executive Vice President-External Affairs and President-Global Commercial, Kelly Tompkins.

At this time, I’ll turn the call over to Gary.

Gary B. Halverson

Thank you, Jess, and thanks to everyone listening on today’s call. Before I review our results for the quarter, I want to briefly address the matter of ongoing shareholder engagement. As you may know, one of our shareholders Casablanca Capital has nominated director candidates for election to our board of directors.

We welcome open communications with all of our shareholders and strive to maintain a constructive dialogue with them. We also remain committed to acting in the best interest of our shareholders. Although we will not take questions on Casablanca today, we do have an update regarding the annual meeting. After taking into account what the company’s board and management believe to be in the best interest of Cliff’s shareholders with respect to our attempts to resolve the ongoing situation with Casablanca. We have set a record date of June 2, for the Annual Meeting, which will be held on July 29, 2014.

With that said, the focus of today’s call is on our earnings results, so we ask that you please keep your questions focused on that topic. We do not intend to make any further comments or statements during this call regarding Casablanca, and I thank you for your cooperation in that regard.

In my first few months at cliffs, we announced a number of decisions to cut spending, suspend projects, idle underperforming assets, and sharpened our capital allocation discipline. During the first quarter, we successfully and safely idled Wabush’s Mine and processing plant. While I regret that this decision impacted the jobs of 500 people, we must strive for continuous improvement in lowering our cost profile.

I’m pleased to report that our first quarter capital expenditures were 55% lower year-over-year and our SG&A and exploration expenses decreased 30%, excluding severance related charges. These severance costs were associated with our overhead delayering efforts and directly related to a 21% reduction in officer-level executives since year-end. As the year progresses, we will continue to look for opportunities to reduce our overhead and capital expenses, as well as evaluate benchmarking strategies to improve our operating costs.

While only a small portion of these cost cutting efforts are reflected in our first quarter results, I’m confident that there is more to come. This first quarter progress has come in spite of difficult weather conditions that impacted our North American operations. As most of you are aware, the first quarter is always slower given the seasonal lock maintenance and freezing of the Great Lakes.

The conditions experienced this winter further magnified this seasonality. Also, pricing for iron ore and met coal products were softer both quarter-over-quarter and year-over-year. While these factors impacted our first quarter results, we are keeping our full-year 2014 outlook largely intact, thanks to the focused efforts and resilience of the our skilled operators at all of our sites.

Having said that, there are a number of positive results to report from all of our business segments. Starting with Bloom Lake, in a quarter where iron ore operations across The Labrador Trough were hampered by severe winter weather. Bloom Lakes production volume was our first quarter record. This bodes well for us as the spring fall will provide for better operating conditions.

In our Asia-Pacific iron ore operations, we generated over $100 million in cash margin, which is better than the last year’s first quarter despite a 19% drop in market pricing and higher freight rates.

In North American coal, excluding lower cost or market inventory adjustments, we generated positive cash margin despite operating in some of the worst market pricing seen in the last decade. And finally, in U.S. iron ore, the business perhaps most impacted by the harsh winter conditions, we are maintaining our 2014 sales volume and cash cost per ton guidance.

Our focus on disciplined capital allocation and cost cutting enabled us to significantly reduce the first quarter borrowings under our existing credit facilities. Terry will provide more details later in the call, but I think it’s important to highlight that we increased our liquidity 32% versus the prior year’s first quarter despite the external headwinds. This increased liquidity will keep us financially flexible and well-positioned to manage through future market pricing volatility.

Turning to end markets for our product, in China, the implementation of our reform agenda with credit tightening and pollution control measures has hampered growth in steel production in 2014, which has impacted iron ore demand and ultimately pricing. Currently, high iron ore port inventories with lower steel utilization rates are barriers indicators, but the mini stimulus past earlier this month gives us confidence that government remains committed to its target GDP rate.

Also, we were encouraged to see the expected increases in quality premiums that I highlighted the last quarter materialized in our results. The higher year-over-year premiums for both our Australian lump and Bloom Lake concentrate products help to partially offset the decline in seaborne pricing. In the U.S., the demand from our customers is stronger than ever. This is driven by the weathers impact on movements of iron ore pellets across the Great Lakes. We experienced over 70 days of negative minus 30 degree Fahrenheit temperature over this winter season.

The freezing climate resulted in the most ice coverage we’ve seen in over 30 years. Essentially halting lake freight and causing our customers to dip into already low steel making raw material inventories. This low raw material inventory has driven some North American steel makers to run at reduced rates or idled production altogether, a dynamic that has directly tightened the U.S. market for flat steel products. While the warmer weather slowly improved shipping and operating conditions, we will continue to work closely with our North American customers to do whatever we can to help deliver pellets to them.

Now turning to the performance of our business segments during the quarter, in U.S. iron ore, first quarter sales volume decreased 8% to 2.8 million tons and included approximately 100,000 tons sold into the seaborne market. This decrease was primarily due to the previously discussed weather conditions. We expect tightness in the pellet market to continue into the second quarter as we are still experiencing some difficulty in moving product across the Great Lakes.

Current ice conditions continued to restrict vessel movements to small convoys requiring Coast Guard icebreaker systems. As a result, product movement across Lake Superior where about 90% of our volume is transported is still very low. Making up for the first quarter, volumes will not be easy, but we expect our 2014 nominations will be delivered. We expect to continue shipping through the traditional summer debt that we have seen in prior years.

The ice on the lakes has contributed to higher water levels, which means we can increase the draft on the vessels or essentially load them heavier. And also there are some idled, currently idled vessel capacity that could be brought in for the season. One thing the weather did not hamper during the quarter was our commercial teams successful execution of an extended pellet supply agreement with our ArcelorMittal.

This will keep our Empire Mine operating through at least 2016, reflecting the excellent commercial relationship we have with our partner. This could not have been done without the hard work and planning from our dedicated Empire team at our Michigan operations. They kept the mine safely running to provide us with the valuable option of extending the mine lives reserves. And also we successfully restarted two idled furnaces at our North Shore facility that were down for the majority of 2013.

For full-year 2014, we are maintaining our U.S. iron ore sales volume expectation of 22 million to 23 million ton. On the DRI front, we remain enthusiastic about the potential for supplying this emerging market. From our North Shore mine, we are positioned to be the natural supplier for DR great pellets to serve any one of the DRI plant projects currently under PPS ability study in the Midwest.

Turning to Eastern Canadian iron ore, first quarter year-over-year sales volume decreased 14% to 1.6 million tons, and included 350,000 tons from Wabush with Bloom Lake making up the remainder of the volume. The decrease was primarily driven by a Chinamax-size vessel shipment that was delayed due to the weathers impact on logistics.

I was very pleased with Bloom Lakes record first quarter production volume of 1.5 million tons, a 10% increase versus prior year’s comparable quarter. Coming off the encouraging quarter, I’m optimistic about the traction we are gaining at Bloom Lake. The decision to indefinitely suspend Bloom Lakes Phase II expansion has given our team the singular focus of improving Bloom Lakes Phase I operations. We expect mill availability and throughput to both favorably impact production volume, which will ultimately improve the cost per ton longer-term.

We have made it clear that we will not be moving forward with Bloom Lakes Phase II expansion alone. During the quarter, we’ve made progress in identifying a wide range of perspective partner candidates. Also, we have engaged our bankers, our data room is set up, and we have a methodical process in place to evaluate potential offers.

All options remain on the table for this asset with the top priority of extracting the highest value for our shareholders. While we work towards attracting a partner for Bloom Lake, the political landscape in Quebec is changing. We are encouraged by the Liberal party’s recent victory in the Quebec provincial elections a few weeks ago.

Historically, this group has been supportive of developing in the natural resources industry. We are maintaining our full-year Eastern Canadian Iron Ore sales and production volume expectations of 6 million to 7 million tons, which is comprised of 5.5 million to 6.5 million tons from Bloom Lake with Wabush making up the remainder. As we finalized Wabush’s idled, we may have additional residual product itself, which would all be all volume upside to our current sales forecast.

Turning to Asia-Pacific iron ore, first quarter sales volume increased 15% to 2.6 million tons from 2.3 million tons in prior year’s comparable quarter. This was driven by favorable timing of vessel shipments. We are seeing additional cost benefits from moving less material, which is driving efficiencies in our loading and hauling costs. This combined with the impacts from favorable foreign exchange rates continues to push this asset left on the cost curve and to the lower end of our cash cost per ton guidance at today’s Aussie to U.S. dollar exchange rate.

Our full-year 2014 expected sales and production volumes remain unchanged at 10 million tons to 11 million tons comprised of approximately 50% lump and 50% fines ore. Now turning to coal, our first quarter sales volume decreased 12% to 1.6 million tons from 1.8 millions last year. This was attributable to lower sales to certain customers due to extended price negotiations and adverse weather related impact.

Just a few weeks ago, the team at our Pinnacle Mine broken another longwall operation world record for the most volume produced in the 24-hour period. Our ability to produce more volume will help lower our unit cost in efforts to remain competitive in this tough pricing environment.

The second quarter met coal benchmark settlement of $120 per metric ton at the port presents challenges in the long-term economic viability of running our mines. However, we are encouraged to see the recent announcements of idled North American capacity, which could be constructive to met coals supply demand market dynamics. We will be following this market closely, and if pricing continues to decline or stays at the current level for a sustained period, we will have to consider other options. In light of the current pricing environment, our team is more focused than ever on squeezing cost out of this business.

For 2014, we are maintaining our sales and production volume expectations of 7 million to 8 million tons, largely comprised of met coal. So in closing, I’m pleased with our operating performance in light of the external environment factors that were plaguing us in the quarter. We have demonstrated meaningful progress in both reducing costs and becoming more focused on extracting value from our assets.

In recent conversions with several of our top shareholders, we have been encouraged to hear that their supportive of the changes to our board and recent actions taken by management to improve the financial performance of the company, we have made good progress, and I expect this to accelerate as we are focused on delivering our near-term cost savings, so that we are well-positioned to enhance long-term shareholder value.

And with that, I’ll turn it over to Terry to discuss our financial results.

Terrance M. Paradie

Thank you, Gary. Despite the pricing and weather, we ended the quarter with over $1.9 billion in total liquidity, a 32% increase compared to the prior year. This is the result of having a higher cash balance of $364 million and amounts drawn under our existing credit facilities of $225 million, a reduction of nearly 60% from the first quarter of 2013.

Our success in cutting capital overhead and operating cost has enabled us to significantly minimize our debt borrowings in our seasonally slowest cash generating quarter. The covenant suspension period implemented in partnership with our revolver bank group during the first quarter of 2013 expired at the end of the first quarter of 2014. We have now resumed our measurement under the facilities previous covenant structure.

This includes a 3.5 times maximum debt to EBITDA ratio and a 2.5 times minimum interest coverage ratio. At quarter end, we were well beneath the debt to EBITDA covenant requirement with a ratio of less then 2.5 times. While I’m comfortable with our leverage position, especially considering the headwinds we face in the normal first quarter seasonality, our near-term target will be to reduce our debt profile.

Consolidated revenues for the first quarter were $940 million, down $201 million from the prior year. The lower pricing impacted our first quarter revenues by $173 million with the remainder driven by lower sales volumes. Cost of goods sold decreased slightly to $877 million primarily driven by favorable foreign exchange rate variances totaling $45 million and $29 million related to the lower sales volumes.

These decreases were partially offset by incremental lower cost to market inventory charges of $33 million. Consolidated sales margin for the quarter decreased to $63 million, which also included $25 million sales margin loss from our Wabush mines operations. Our first quarter SG&A and exploration expenses decreased 30% year-over-year to $50 million, excluding $5 million in severance costs.

Our first quarter miscellaneous net expense increased to $59 million and included $39 million in Wabush related costs, $16 million related to minimum take-or-pay volume commitments with the QNS& rail line as a result of our Bloom Lakes delayed expansion, and $7 million related to unfavorable foreign currency exchange remeasurements. Excluding some of these special items incurred during the quarter EBITDA from our core operations was approximately $177 million.

First quarter 2014 results included an income tax benefit of $22 million versus a benefit of $6 million reported in last year’s first quarter. The increase is mainly attributable to a higher expected full-year effective tax rate and a decrease in year-over-year net income. Our expected effective and cash tax rates for the full year including discrete items is expected to be approximately 24%.

Turning to our business segment performance, revenue per ton decrease in all of our business segments year-over-year primarily driven by a 19% lower market pricing for iron ore and a 13% lower market pricing for met coal, higher freight rates from both Canada and Australia to Asia also contributed to lower realized revenues. Partially offsetting these unfavorable revenue impacts were increased premiums for our high-quality products.

During the quarter, our revenues reflected a $38 per ton pallet premium attributive to USIO export sales, a $12 per ton iron content premium for Bloom Lakes concentrate in Eastern Canada and a $16 per ton lump premium in Asia-Pacific, which is about half our volume in that segment.

As expected, on a percentage basis, the decrease in USIO revenue per ton of 9% was smallest compared to our seaborne expose iron ore segments. This was largely driven by the long-term supply agreements that mitigate seaborne iron ore pricing volatility. Customer mix and provisional price settlement also unfavorably impacted USIO year-over-year revenue per ton results.

In addition to lower pricing and increased freight rates APIO’s revenue per ton of $96 was unfavorably impacted by $6 per ton related to iron ore great penalties and $4 per ton of foreign exchange hedging losses during the quarter. Our Eastern Canadian Iron Ore revenue results included 350,000 tons are sold from Wabush Mine, which achieved on lower realized price compared to Bloom Lakes high-quality concentrate.

As detailed in last night’s earnings release, the first quarter year-to date average iron ore price of $120 per ton is the underlying price assumption with in our full year 2014 iron ore segment outlook. U.S Iron Ore we have reduced our full year revenue per ton expected range to $100 to $105 per ton. We are at the lower end of the previous expected range of $105 to $110 per ton and the 8% lower seaborne iron ore price assumption took our range down a notch.

Despite this the revenue per ton sensitivity for every $10 per ton change implies seaborne iron ore pricing for the year is approximately $1 per ton impact to the USIO realized revenue expectation. In Eastern Canadian Iron Ore, our revenue outlook remains unchanged that $95 to $100 per ton despite that the 8% decrease in the underlying iron ore price assumption. This is driven by the benefit we expect to achieve from realizing higher-quality premiums and lower freight rates versus our previous expectation.

Our Asia-Pacific Iron Ore outlook was reduced to $95 to $100 per ton in line with how you would expect the 8% lower seaborne iron ore price assumption to impact our realizations.

For North American Coal, we are lowering our full year revenue per ton expectation by $5 to $80 to $85 per ton reflecting a lower market pricing for met coal. We currently have approximately 60% of our sales volume price at approximately $85 per ton with only met coal last price.

Now, looking at our segments cash cost results. U.S. Iron Ore first quarter cash costs were $65 per ton up 9% from prior year’s comparable quarter. This was driven by higher maintenance activity and energy costs.

Cold weather contributed higher natural gas pricing and electricity rates across the country. However, I am pleased that our cash cost results were at the lower end of our expected range. Also keep in mind that the inventory produced during the first quarter, when energy rates were elevated will be sold in later quarters in 2014.

So those elevated costs will be reflected over the remaining quarters as the inventory is sold. Our US operators are working diligently to offset some of these energy driven pressures by reducing contractor spending.

For the full year, we are maintaining our cash cost expectation in USIO at $65 to $70 per ton. First quarter cash cost in Eastern Canadian Iron Ore were $104 per ton and reflected the results from both Wabush and Bloom Lake mines. At Bloom Lake excluding the lower cost of market inventory adjustments of $7 per ton, cash costs were $87 per ton compared to $89 per ton in the prior year’s comparable quarter. The decrease was driven by favorable foreign exchange rates partially offset by increased mine development work.

In the Asia Pacific Iron Ore first quarter cash costs were $56 per ton down 25% from a year ago quarter. Do not have the year-over-year improvement was driven by favorable foreign currency exchange rates with the remainder of the improvement driven less all raw material movement and increased fixed cost leverage.

In our North American Coal segment, we also incurred a lower cost from market inventory adjustment of $22 million or $14 per ton during the quarter. Last year’s first quarter results also included $2 million or $1 per ton in lower cost for market inventory adjustments.

Excluding this adjustments in both periods, our North American Coal cash costs were $86 per ton, a 4% decrease from prior year’s first quarter. The decrease was driven by continued focus on improving operating efficiencies. Also because a lower cost from market inventory adjustments are essentially timing differences over the cost our. expense to our income statement. We are maintaining our full year cash cost per ton expectation of $85 to $90 per ton.

On a consolidated level, we successfully reduced our first quarter capital expenditures by $127 million or 55% to $103 million. The decrease was largely driven by lower spending at Bloom Lake where the team is very focused on extracting value from the operations for space. For the full year, we are maintaining our capital expenditure outlook range of $375 million to $425 million.

We are also maintaining our expectation for full year SG&A and exploration expenses of approximately $200 million excluding severance-related costs.

In closing, we have begun delivering our year-over-year cost savings as demonstrated on our first quarter results. Our balance sheet position is substantially improved from where we were a year ago leaving us well positioned to manage through the inevitable volatility and commodity pricing.

Our ability to deliver these improvements in a seasonally slow quarter through tough operating condition gives me confidence and our ability to successfully deliver the cost reductions within our 2014 outlook.

With that Jess, I think we’re now ready to open the call for question.

Jessica Moran

That concludes our prepared remarks for today’s call. We request that you please keep your questions to our earnings results and outlook. Operator, can you please open the line to begin our question-and-answer session.

Question-and-Answer Session

Operator

(Operator Instructions) Thank you. Your first question comes from Mitesh Thakkar. Your line is now open.

Mitesh B. Thakkar – FBR Capital Markets & Co.

Good morning everybody and congratulations on the good cost performance in the quarter.

Gary B. Halverson

Thanks, Mitesh.

Mitesh B. Thakkar – FBR Capital Markets & Co.

My first question is on the U.S. Iron Ore side, look like weather driven issues had increase the call for the balance of the year for that segment to perform. How do you think about you know, the amount of inventory you have and what it means for the cash flows for the back half of the remaining nine months, and are there any potential logistics constraints which could show up and prohibit you from achieving the guidance on the full year basis?

Gary B. Halverson

Thanks Mitesh. Maybe Terry will chime in time, but basically as they were still maintaining the full year guidance on total shift product or customers. Obviously the weather plays into it, if I look that last year’s whether we, we had an early close for the season. Based on what we are looking at for current shipping and the availability of by quarter. We thing that we are going to be able to make it, and we won’t get it all back in second quarter, but we are looking at late third quarter possibly into the fourth quarter acquiring any terrible weather for this coming winter.

Terrance M. Paradise

Yes, Mitesh from a cash flow standpoint obviously the first quarter on traditionally is a quarter we build up our inventory balances. So in the second part of – the second half of the year is when we wind down those inventory balances so we generate positive cash flow. You can see for the quarter, we had negative cash flow from operations of $82 million with a good portion of that as a result of the build in inventories.

Mitesh B. Thakkar – FBR Capital Markets & Co.

Is there any way to quantify that?

Terrance M. Paradise

From a timing standpoint I think it will be based on how we schedule out the remaining accounts for the year, we are keeping our guidance that $22 million to $23 million tons we’ve done just under $3 million tons for the quarter. So you can probably spread that, maybe less in the second quarter and more in the third quarter and fourth quarter because we are still dealing with weather a nice conditions in the Great Lakes.

P. Kelly Tompkins

Mitesh, this is Kelly just couple of other comment. I’m sure other analyst are questioning our ability to meet the volume for the balance of the year given the condition on the lakes I think there is a couple of things to consider. One, we fully expect idle vessel capacity will come online certainly be an economic incentive for some of these vessel carriers to come online.

Secondly, lake levels will be up so will load a little heavier. And then I think equally importantly, typically have all wall in the summer months so we would expect a shift on a much more radical basis across the remaining quarters of the year. And we do always build in a little bit of contingency in the fourth quarter just because it’s uncertain in terms of how earlier late winter conditions will arrive. So we have factored in some of that contingency as well so that gives us reasonable confidence that we can make the volume commitments.

Mitesh B. Thakkar – FBR Capital Markets & Co.

Great, thank you for the color guys good luck.

Terrance M. Paradise

Thank you

P. Kelly Tompkins

Thank you.

Operator

And your next question comes from Michael Gambardella from J.P. Morgan. Your line is now open.

Michael F. Gambardella – JPMorgan Securities LLC

Yes, thank you and good morning. How much of the total tonnage so far year-to-date in the Great Lakes has been affected, do you think by the weather?

Gary B. Halverson

The shipping was 2.8, so it’s – we normally don’t have any product during that time period anyway. So the total is, I’m not sure of the total…

Jessica Moran

Last year was 3.1, so….

Terrance M. Paradie

Above 10% then…

Jessica Moran

Lease and then there is other guys on the Great Lakes that are shipping vessels to, I don’t how much they’ve missed out, but…

Gary B. Halverson

Yes. Our expectation as Kelly mentioned now, we will be able to move the times in the second, third, and fourth quarter. And we historically have been able to hit those average volumes in those quarters.

Michael F. Gambardella – JPMorgan Securities LLC

All right.

Gary B. Halverson

Yes. So, yes, I guess our focus Michael.

Michael F. Gambardella – JPMorgan Securities LLC

I was going to say one of your customers has been delayed from a shipment from you into another quarter, what’s the pricing that they get on that shipment?

Gary B. Halverson

Mike, we wouldn’t comment on particular customer pricing, but we are working. I was up at one of our customers for most of the day on Wednesday and a couple of my sales guys are outlook customers today. We are working hand-and-hand with them. And part of the challenge for a number of our customers, of course, is they work their inventory down low as they are managing their working capital. So the days of having had some buffer inventory is not there. So, our customers are recognized if they’re part of the solution here as well. So it’s a customer-by-customer hand-and-hand, working relationship to work through this and they all understand there in a similar situation and are supportive of our efforts.

Michael F. Gambardella – JPMorgan Securities LLC

There is the customer – say customer shipment has delayed by three months. And the pricing, I’m not asking for the specific pricing, but say, the pricing is referenced off of seaborne, is it the seaborne what it was supposed to get it or the seaborne when you shift with three months later?

Gary B. Halverson

It’s going to be varied by customers, it’s going to be reflected in their particular contract pricing.

Michael F. Gambardella – JPMorgan Securities LLC

Okay. And then last question, how much of the penalty did you cost get in the quarter due to higher energy costs?

Gary B. Halverson

The total – if I use the USIO was the biggest impact for all the sites. The total was about $45 million. On an annualized basis that’s about $2 a ton. Obviously from an impact first quarter, it’s where we are expecting it all to land. About two-thirds of that was driven by natural gas pricing and one-third by electricity, mainly in Michigan.

Jessica Moran

Yes, the $45 million increase would have been over Q1 of 2013 energy rates.

Gary B. Halverson

And as I mentioned in my comments to, Mike is, that’s part of – a lot of that’s built in the inventory that’s on the balance sheet now, and we’ll see some of those costs coming through in the second, third, and fourth quarter, as we move those tons.

Michael F. Gambardella – JPMorgan Securities LLC

Okay. And then when you bring on, when people bring on some of those idle vessel capacity to accommodate the additional flows of iron ore in the second, third, and fourth quarter, who pays for that? Is that customer or is that you?

Terrance M. Paradie

Mostly.

Gary B. Halverson

Mostly paid by the customer, but it varies by contract.

Michael F. Gambardella – JPMorgan Securities LLC

Okay. Thank you very much.

Gary B. Halverson

Yep, thanks.

Operator

Your next question comes from Tony B. Rizzuto from Cowen & Co. Your line is now open.

Tony B. Rizzuto – Cowen & Co.

Thank you very much. Hi, everybody.

Terrance M. Paradie

Hi, Tony.

Gary B. Halverson

Hi, Tony.

Tony B. Rizzuto – Cowen & Co.

My first question is more strategic in nature, and I guess Gary, I would like to know what your finding from your valuation thus far over the technical and engineering aspects of Bloom Lake. And I’m just trying to understand better your costs and why there is so high compared to others obviously you are operating in the trough at much lower cost. And I know, certainly, volumes are a factor and efficiencies of scale et cetera, economies of scale, but do you think the engineering there is flawed in some ways, I would like to hear your thoughts on that please?

Gary B. Halverson

Sure. You spot on from, mainly it’s a volume driver for Bloom Lake when you compare to what the neighbors are producing there as well. And that’s why we see the opportunity for reducing half of the Phase 1, and obviously if you expand the 13 million, 14 million tons, do you see that net drop. There are some fundamental differences as well as to how we grind and produce our product. It’s based on us using spiral concentrators in there. There is no magnetite recovery process to it.

So it all factors into some of the variability that you would see to, it’s comparing fruit, but not apples-to-apples between the products. That being said though, we’re still in the early days of that project. And I – as I said at the beginning, we’re seeing a record of 1.5 million tons is the first thing out of the suite, the challenge I gave for the guys was just within the last couple of months of how come we focus just on Bloom one and extract maximum value both in terms of our capital and operating cost.

One of the things we’ve seen is now we’re getting increased productivity improvements and what you are going to see coming after that is a definite lowering of unit cost coming off the back of that, but there is a bit of a lifetime first comes in production then comes to lower cost. Overall, the difference in focus with the guys and what they can do. We’ve seen some pretty good daily production rates and then just moving out in understanding new ore body and how we mine it.

We also had some increased cost in Q1 just based on where we are at from our stripping ratios and overburden. Overburden in the past has been capitalized that we now take it as operating. And that overburden essentially goes from close to million tons to zero in the second quarter. So there is changes occurring in that, that’s going to continue to make us more efficient at that plan

Tony B. Rizzuto – Cowen & Co.

I appreciate that. Now, I understand, correct me if I’m wrong, but I think, I have heard that in the bankable feasibility study when it was done on Bloom Lake that it originally called for magnetic recovery system or is it magnetite recovery I forget. But I’m wondering, and then I understand that that was going to be installed at a later point. I wonder, if you can tell me how was that affected your recoveries there and if you were to implement that system what kind of capital cost you are talking about, is that some that you think is required there?

Gary B. Halverson

Let me give you a quick snapshot. CT did have any original feasibility document a plan to put in a magnetic recovery plan. They grossly underestimated at the time when we want capital to go into it. Based on this low pricing we’re in just based on what I see for recoverability of the magnetic iron, I don’t see the feasibility of having down there.

I think our focus right now is really on what we currently have in front of us, while we can do to partner up into Phase II to actually extract that, the volume based on the current plan the way it is. But there is an opportunity in the rising market down the road, I think we’ve got to refocus on that based on that disciplined capital that we look at.

Tony B. Rizzuto – Cowen & Co.

Okay, all right. and then my second question is on a different matter. but overall of your guidance appeared somewhat conservative and I was wondering is that by design or for example with respect to Asia-Pacific, are you building in some currency reversal, it sounded like some of the factors you described were more sustainable in nature. So I’m just wondering, why the continued same guidance for the year despite a very stellar first quarter cost performance there and that type of thing?

Gary B. Halverson

Thanks. It is only first quarter and we’re early out of the gate. I guess Terry to comment on a couple aspects to that – but part of it’s driven by changes in FX rates and well…

Terrance M. Paradie

Yes, yes. I think Tony, from the standpoint, our range that we’ve given guidance of 65 to 70, we’re at the low end of the range. we’re still within that range. That is biggest piece that we’ve seen in the quarter where we’re at is the fact of currency from a plan standpoint the Ozzy dollar we plan for both $0.90 right now. today, the Ozzy dollar is at $0.93, $0.94, and therefore there is some risk with respect from a cost standpoint with the Ozzy dollar. so, I think there is a – we’re at the low end of that range, but again, in the first quarter, the fact that we’re dealing with, I think some currency exposure and where we’re at from a plan standpoint versus where it is today. We are comfortable with that range at this point.

Tony B. Rizzuto – Cowen & Co.

Okay. And just one more quick question just back to Bloom Lake for a second, Gary, I just wanted to – do you think there was adequate delineation the orebody and what are you guys – it sounded like you’ve got obviously higher mining expenditures you’ve been doing push backs and you’ve had some higher stripping et cetera, but just your thoughts on that?

Gary B. Halverson

Sure. I guess the easy answer is that we need more delineation, and we identify that towards the end of last year was, we were just doing our analysis of three ore bodies or three pits based on total iron and we actually differentiate that to get a better feel for recoveries within the circuit. so we’re doing that. But part of it is we’re stepping back and looking at the actual drill core data to actually get a better differentiation from there as well.

Overall, it doesn’t change where we’re at from mining the three pits. It’s looking at optimizing mine planning and where we go both from blast-hole data and from understand the orebody with more clarity, so that that will lead to better focus of where material goes in terms of feeding and blending.

Tony B. Rizzuto – Cowen & Co.

All right, very good. I appreciate the response. Thank you.

Operator

The next question comes from Timna Tanners from Bank of America. Your line is now open.

Timna Beth Tanners – Bank of America Merrill Lynch

Yes. Hey, good morning. happy Friday.

Terrance M. Paradie

Good morning

Gary B. Halverson

Good morning, Timna.

Jessica Moran

Good morning.

Timna Beth Tanners – Bank of America Merrill Lynch

I just want to get a little more sense about the export opportunity, if you could refresh us on how that’s proceeding given the pellet premiums and how exports look going forward and what they might have looked like in the quarter?

P. Kelly Tompkins

Yes. Hey, Timna, it’s Kelly. I think you’d recall our guidance was 1 million tons of export this year, comparative a little over to last year. And so we’re still holding at that guidance. now if there’s opportunities throughout the course of the year to retain some of that tonnage in the Great Lakes, we’ll do that, but there is a healthy pellet premium right now, we know. but at this point, we’re just holding another the million ton guidance for exports.

Jessica Moran

There was a higher thousand tons in the quarter from that.

Timna Beth Tanners – Bank of America Merrill Lynch

Okay, thank you. that’s helpful. and then also, I thought if I missed did you give us on the weather resolution, it sounded like there will still be some spill over into Q2 in terms of Great Lakes and still sign out, but – and it will take throughout the year to kind of resolve that situation, is that the way to think about it that there will be some spillover?

Gary B. Halverson

That’s a good summary. we’re still saying some of factors still have coastguard guidance of the vessels and with a better mother nature going in the right direction here, that will rapidly increase and everybody is hoping for that, but based on our analysis we have the capacity to recover Q3, Q4.

Timna Beth Tanners – Bank of America Merrill Lynch

Okay, makes sense, only other little question I had if I could was on the coal side, what is it going to take for you to make the decision on whether to continue? is it going to be a couple of quarters that I mean you noted that other people setting is helping the situation, but what would it take for cause to make a decision on setting, you said flatter below current levels, I’m just wondering what timeframe you might be making a decision?

Gary B. Halverson

Thanks for that Timna. The guys have done a great job of continuing to lower the unit cost and they said continuing to hit new records and productivity. so with that we’re in that lower one-third quartile for North American producers and we’ve seen, we’re starting to see in this, I think I mentioned last time, we’re just the – one of attrition, which is a natural evolution to take some of the supply over the make.

we’re seeing that coming into play, but specifically, for our assets and we want to focus each mine has a different characteristics that we have to look at for – its cost of – net cost of operating the cost to title and to look at the – our customer base and marketing of that. we are currently in the process of doing that based on where we’re at. but at the end of the day, as I said, we’re – we don’t want to be cash negative. so we’re looking at what the effects are, what the trigger points are? Once we do that analysis, we can make a quick decision on that the issues when you make a – an idling decision, it’s for a longer period of time. So we want to make sure that we do this right, but we’re the guys are on top of it now. Kelly?

P. Kelly Tompkins

Turning to maybe a couple other supplemental points, one we would want to gear timing of the – relative go longwall move. this will at least disrupt at the operation, so that would play into it. But – and at this point, we’re estimating there has been close to 10 million tons have been taken out of the domestic market already in terms of actual idle capacity, or at least on the verge of idling based on other announcements.

And so we’re looking at it where we’re at on the cost curve, strength of our product mix, customer base all those things have to be factored into the decision along with obviously the hard analysis of the economics, which is well underway. but at this point, we’re still in monitoring mode.

Timna Beth Tanners – Bank of America Merrill Lynch

Okay, thanks.

Operator

(Operator Instructions) your next question come Jorge Beristain from Deutsche Bank. Your line is now open.

Jorge M. Beristain – Deutsche Bank Securities, Inc.

Good morning, ladies and gentleman. my question I guess is more of a strategic nature for Gary, just if you could talk to the recent announcement from versatile P&A that you guys will be one of the suppliers to the iron ore for their HBI facility, and you’ve been talking about the DRI opportunity in North America for a while. Could you talk in terms of sort of $21 million ton baseline that you’re doing for U.S. legacy, how much of that could ultimately start to go to the alternative many mill market, and what would be the kind of CapEx for each million ton that you start to supply to the that market.

Gary B. Halverson

I can’t speak specifically on, I think as I said in the beginning, I think we’re positioned pretty well as a supplier for the DR, DRI marketplace. And that’s – we believe that’s going to come on to team over the next three or five years. In terms of our – I think I mentioned last time, we’ve actually done all the test work on North Shore, we can produce about $3 million tons of product DR quality low silica pellet.

The cost of that based on our pre-fees level is several hundred million dollars and part of our process is to make sure that based on the various people that are out there, other companies that we position ourselves for the long-term to be able to step into this in the right way. Kelly?

P. Kelly Tompkins

Yes, very good. As Gary said, we’re not going to comment on particular partner to customer opportunities. but I think it’s fair to say that we’re comfortable with the technical feasibility. we’ve recently noted down the CapEx estimates for making the pellet and really right now we’re evaluating a number of possible options and that’s whether to just purely be a DR grade pellet supplier or whether we would go into a JV structure for example, in a DRI facility.

and I think that as we’ve said on other calls, geographic considerations are very important. so looking at EAF opportunities around the Great Lakes from a regional standpoint to really maximize, the margin potential and the transportation factor will be a key ingredient in our decision-making process. But again, we see it as a very viable market opportunity to maybe offset some of the export tons down the road.

Jorge M. Beristain – Deutsche Bank Securities, Inc.

Great. And if I could just have a follow-up, on the coal business, could you just remind us of your volume targets for 2014, how much of that is already fixed price contracted?

Gary B. Halverson

Yes. Our 60% has already been priced and committed for the year. So the remainder of the 7 to 7.5 million tons that we’re – we’ve put in our guidance is met coal product, that hasn’t been priced recommended yet.

Jorge M. Beristain – Deutsche Bank Securities, Inc.

And that’s an average price of $85 a ton to 50%, right?

Gary B. Halverson

50%, right.

Jorge M. Beristain – Deutsche Bank Securities, Inc.

And is the remaining uncommitted product at this point viable, given where market prices are in the U.S.? In other words, are you cash flow positive?

Gary B. Halverson

It depends on – we’re really looking at how we sell that product into the market, and we’ve been fairly projecting with negotiating with the customers on that. So it’s a bit of a give-and-take there. And that factors in, as Kelly said to the overall balance point of whether you idle an asset, certainly don’t want to go negative, but we’re running right on a fine wire right now.

Jorge M. Beristain – Deutsche Bank Securities, Inc.

Okay. Thank you.

Operator

The next question comes from Evan Kurtz from Morgan Stanley. Your line is now open.

Evan L. Kurtz – Morgan Stanley & Co. LLC

Hi. Good morning, everyone.

Gary B. Halverson

Good morning.

P. Kelly Tompkins

Good morning.

P. Kelly Tompkins

Hi, Evan.

Evan L. Kurtz – Morgan Stanley & Co. LLC

I just wanted to get an update on Asia-Pac. You mentioned in the press release that you’ve been a little bit less material this quarter. and I was wondering their ageing mines I just wondered to get kind of the outlook for. Are you see shipping ratio is going and all the senses and so forth surprise to see that was actually moving in the right direction?

Gary B. Halverson

Yes. It actually was good. As for our plan for the first quarter was that the stripping ratio of 5.0, and we actually ended the quarter at 3.6. So, it was quite a drop in total movement. We actually mined at $5 million tons a month. Most of that, we have a whole series of pits and a lot of the movement was over the Windarling pits, so I think W1W for. And it’s coming back a little bit better and the guys have guys have done some good inroad Stephen pit Poloz and obviously pull in that strip back. So that’s just optimization that the guys are continuing to do. I can’t really say forward in the plan, but that’s a good indication of some of the cost savings focus that the guys have.

Terrance Paradie

Yes, Evan, I think the team has really been. We had a big change for the guys have. I think the team is really been, we had a big change going from one large pit to multiple parts. So the teams really focused in on their mine plan and operating efficiencies and they continue to focus on how to be, extract the most ore out of this at the lower strip ratios and that will be continued focus as they moved to the end of life of mine.

Evan L. Kurtz – Morgan Stanley & Co. LLC

Okay, thanks. And one other question on Bloom Lake. You mentioned you said at the data room. Have any potential parties come to you so far in the process?

Gary B. Halverson

I just can’t comment on specific parties.

Evan L. Kurtz – Morgan Stanley & Co. LLC

No specifics, but is there any interest coming toward you? No names or anything like that but…

Gary B. Halverson

Yes. There has been interest and obviously it is a process of an early stage of it. So it’s a little too early that to comment on anything specific, I guess within that, but it’s fair to say that we have been specifically approached already.

Evan L. Kurtz – Morgan Stanley & Co. LLC

Great, thanks. And maybe just one follow-up on Tony’s question. I thought it was interesting, the initial project call for a magnetic recovery plans. If I recall, I mean, the problem seems to be that the mill is not really homogenous and you’re having problems turning some of the spiral separators. It seems like that would be a solution to that problem. And I just trying to get a sense of it, you mentioned that the CapEx is very high as I was hoping you can provide may be a range or neighborhood or what do you think there might be? And then is that really required to get a major step function change in cost and what do you think that could actually deliver?

Gary B. Halverson

Yes, in general, the numbers are $200 million to $300 million of CapEx to do that. I would be pulling my memory banks to figure out the percentage, but it was in the order of 5% to 8% or something of the product that you could effectively recover against that. When we did the analysis background on that is, you just couldn’t justify in today’s price environment to. You got a couple of things going on there and you’ve got a – it’s the grind size of that material, a lot of energy costs, and then you got to run everything across those magnets. And then obviously that’s a big differentiator to say other mines especially in our U.S. I/O mines.

That being said, it’s not as – it’s a different product mix in those pits.

Terrance M. Paradie

Yes, just to clarify also on the consolidated Thomson days, when they talked about the mag, the mag line. It was also just based on the main pit and the east pit. We have since explored into the west pit, which is a higher hematite sort of pit. So it’s a different sort of volume that we are dealing with today than what they initially had.

Evan L. Kurtz – Morgan Stanley & Co. LLC

Great. Thanks so much.

Operator

And your next question comes from Nathan Littlewood from Credit Suisse. Your line is now open.

Nathan D. Littlewood – Credit Suisse Securities (USA) LLC

Thank you very much and I appreciate the opportunity. I mean I had a question first off we’ve got Eastern Canada and pricing there. You guys have dropped the IODEX reference price from $128 to $120 a ton. When I look at the sensitivities that you’ve provided previously there, one would have thought that would also being a downgrade to their pricing guidance for Eastern Canada to correspond with that. That doesn’t seem to being the case, you’ve actually maintained that pricing guidance.

When I look at what’s going on with sort of valuing these premium at the moment and the freight market, I struggle to sort of reconcile that. So just wondering if you could talk a little bit about what is behind the apparent upgrade to your Eastern Canada pricing expectations there?

Gary B. Halverson

Yes, Nathan, what’s really happening here is, we give a pricing band here. So your expectation that we should have lowered to the next band downwards is absolutely correct. There is couple of things happening there from, you got to step back and look at, that is one variable that we look at in the sensitivity, but we also make estimates around FE content from premium standpoint. We also look at freight cost and what our expectations are there.

So what’s happening is the market price has taken us to that lower band, but we’ve also seen higher FE premiums than what we had planned for, and our expectations are on our original outlook, as well as from a freight standpoint, we are also seeing, receiving better freight rates, because we are doing a higher mix of Chinamax vessels than we had previously planned for. And that’s taking you from down that 8% and that’s putting you it back into the sort of the mid pack of that band we left in there.

Nathan D. Littlewood – Credit Suisse Securities (USA) LLC

Got it. Okay, thank you. The other question was just on sort of liquidity in the balance sheet when I look at the consensus estimates for free cash flow for this year, there is just over $300 million. I would expect that there is probably going to be a bit of a reversal of the working capital situation from the March quarter consuming part of that $300 million for the full year. So it doesn’t look like there is going to be a whole lot of cash generated, and therefore not much change to the total net debt position.

As you know, the covenants have come back from holiday now, and it looks to me that on both of sort of consensus or our own price deck, you guys are going to – potentially going to have problems with that 3.5 to 1 debt to EBITDA covenant by the September quarter of this year. Just wondering if you could talk a little bit about where we’re at with refinancing and maybe how you’re thinking about the capital structure going forward?

Gary B. Halverson

Yes, Nathan, the way I look at it is, we are sitting here with a position liquidity position. We’re back on the debt to EBITDA ratio. We ended the quarter under 2.5 times. We monitor that very, very closely, and we look at our own plan. We look at, we sensitize that and we are always taken a hard look on when we do we think we are going to have some challenges if pricing goes down. So, it’s something we are really focused on as a management team.

That being said, I don’t necessarily depending on price you see happening. I’m not sure, third quarter would be a problem for us based on the way we look at it. But any event, we have good relationships with our banking partners, and if we needed to go for another amendment or some covenant relief, we are comfortable we can make that happen, and we will do that far in advance or less having any challenges from the 3.5 times debt to EBITDA coverage.

Nathan D. Littlewood – Credit Suisse Securities (USA) LLC

Okay. Thank you very much. I appreciate it.

Gary B. Halverson

No problem.

Operator

That’s concludes our call for today. I’ll be around for the remainder of the day if any of you have follow-up questions. Thank you.

Operator

This concludes today’s conference call. You may now disconnect.

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